Inheriting money can evoke a mix of emotions—grief, gratitude, and often confusion. While it may provide financial relief or opportunity, it also introduces new responsibilities and decisions, especially when it comes to taxes. As an advisor, I frequently work with individuals navigating this transition. Many want to honor their loved one’s legacy while making sound financial choices—but they don’t always know where to begin.

1. Is the Inheritance Itself Taxable?

Federal estate tax may apply to the estate of the deceased, but not to the beneficiary. In 2025, only estates worth more than $13.61 million (for individuals) are subject to federal estate tax. If the estate is below this threshold, there is generally no federal estate tax to worry about.

However, state-level estate or inheritance taxes may apply depending on where the decedent lived or owned property. A few states, such as Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania, impose inheritance taxes—taxes paid by the person receiving the assets.

Washington State: The estate tax exemption increases from $2.193 million to $3 million per person, for deaths on or after July 1, 2025. Why you should care is that the inheritance you just received may push your estate over this threshold.

✅ Tip: Consult with a tax advisor familiar with both federal and state laws to determine if taxes apply to your specific situation.

2. Understand the Assets You've Inherited

Not all inherited assets are treated the same for tax purposes:

• Cash: No immediate tax is due when you inherit cash.

• Retirement Accounts (e.g., IRA, 401(k)): These are usually taxable when withdrawn unless it's a Roth account. Under the SECURE Act, most non-spouse beneficiaries must deplete the account within 10 years.

• Investments (stocks, mutual funds): These receive a step-up in cost basis to the fair market value at the date of death, which can significantly reduce capital gains tax when sold.

• Real estate: Like investments, real estate gets a step-up in basis. If you sell soon after inheriting, little or no capital gains tax may apply.

• Business interests: These can be complex and may require a valuation, and may have estate tax implications or ongoing income tax concerns.

3. Income in Respect of a Decedent (IRD)

Some assets—like final paychecks, accrued interest, or distributions from tax-deferred accounts—are considered "Income in Respect of a Decedent" and are taxable to the recipient when received. There’s no step-up in basis for IRD assets.

4. Reporting Requirements

While receiving an inheritance may not be immediately taxable, you may have future reporting obligations:

• Form 1099-R: If you take distributions from an inherited retirement account.

• Schedule D: If you sell inherited stocks or real estate.

• Form 1041: If the estate earns income during administration, it may need to file a fiduciary income tax return.

• State returns: Some states have separate forms for reporting inheritance tax obligations.

5. Timing Your Moves

Don’t rush to make significant financial decisions. Emotional decisions often lead to tax inefficiencies. For example, prematurely selling investments could trigger unnecessary capital gains, or failing to make required minimum distributions (RMDs) from an inherited IRA could result in penalties.

6. Investing the Proceeds

Once you understand the implications, the next step is determining how best to utilize the funds. Key considerations include:

• Time Horizon: Are these funds for short-term needs, a future home purchase, retirement, or generational wealth transfer?

• Risk Tolerance: Your investment choices should reflect your comfort with market volatility and your overall financial goals.

• Tax Efficiency: Taxable accounts benefit from strategies such as municipal bonds, ETFs with low turnover, and tax-loss harvesting.

• Retirement Planning: If you’ve inherited cash, consider maximizing contributions to your own retirement accounts (e.g., IRAs, 401(k)s) to lower your taxable income.

• Diversification: Avoid over-concentration in inherited assets, especially if you received a large amount of employer stock or business equity.

• Debt consolidation: Consider using some of the cash proceeds, if any, to decrease your current debt obligations. Credit cards and your mortgage are just two examples.

• Professional Advice: A fiduciary financial advisor can help create a diversified, tax-sensitive investment strategy tailored to your new financial position.

✅ Tip: Don’t assume that what worked for the decedent is automatically best for you. Your circumstances—and tax bracket—are likely different.

7. Consider Charitable Giving

If you are charitably inclined, inherited assets can be strategically donated to reduce your taxable income. For example, donating appreciated stock directly to charity allows you to avoid capital gains and still claim a charitable deduction.

8. Estate Planning for Yourself

Now that you've inherited assets, it's a good time to update your own estate plan. This includes:

• Updating wills and trusts

• Naming new beneficiaries on your retirement accounts

• Considering lifetime gifting strategies to reduce future estate taxes

Final Thoughts

Receiving an inheritance is both a financial and emotional milestone. It can bring added security, but also complexity. Each decision you make today affects your future—and potentially the next generation. The best next step? Take a breath, seek professional advice, and move forward with thoughtful, informed planning.

Need help managing your inheritance wisely?

Contact Jim Falcone, AIF, to schedule a confidential consultation. We can help you navigate taxes, investment planning, and estate issues with confidence.